Cameron has one last chance to reform economy

Commentary: U.K. struggling under two structural burdens

By

MatthewLynn

LONDON (MarketWatch) — British Prime Minister David Cameron might look good on the world stage, fighting a successful war in Libya , or appearing with President Obama. But together with his Chancellor George Osborne he has not impressed his constituents on the economy.

His government will not be known for economic reform. It is relying completely on gradually reducing the deficit, keeping interest rates low, and allowing the Bank of England to print lots of money, to fix the economy.

But there is little sign of it working, they will be lucky if the economy grows more than 1% this year. What they need is supply-side reforms, and the budget on Wednesday, which sets tax and economic policies for the year, is the right time to unveil them.

Underneath the U.K.’s over-indebted, high-tax economy, there is still an entrepreneurial country struggling to escape. But it is going to have a hard time emerging without any encouragement from the government.

This week’s budget will be the third since Cameron and Osborne took charge of the economy. Way back in 1981, Geoffrey Howe presented the third budget of Margaret Thatcher’s government. With its commitment to radically squeezing public spending paving the way for deep tax cuts, that budget was later seen as a crucial moment in her premiership. It went radically against the conventional wisdom of the time. Indeed, it provoked a furious response from 364 leading economists of the day, including Mervyn King, now the governor of the Bank of England. But over the course of a decade it was proved triumphantly right, and laid the basis for a sustained recovery.

Reuters

Cameron addresses a session at the World Economic Forum.

There is scant prospect of anything that goes against the conventional wisdom from Osborne this week. Instead, he seems locked in to the conventional economic wisdom.

His strategy is to modestly reduce the deficit to keep the U.K.’s triple-A rating, whilst relying on cheap money and quantitative easing on a massive scale to keep the economy alive.

The U.K. has now printed the equivalent of 20% of its GDP in new money, hosing the economy with cash to keep it afloat. It is perfectly sensible, but is lacks any vision for where the country should be going. True, pumping up demand will stop the economy collapsing, just as a shot of adrenaline may stop a patient from dying. But it won’t restore it to health.

The U.K. has two main structural burdens. A debt mountain that now amounts to more than 500% of GDP, according to McKinsey data, only Japan’s is higher. And a state sector that now accounts for 50% of GDP, again among the highest in the world. Big debts and big government, it is not exactly a recipe for prosperity.

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Remarkably enough, there is an entrepreneurial revival struggling to emerge out of the U.K . A combination of a big devaluation in the pound in 2008 and 2009 and ultra-low interest rates, are slowing rebalancing the economy.

Despite the image of a country that relies on the City of London, the U.K. actually has a fairly broadly-based economy. Just take a look at where people are making money. According to a survey this week by the wealth manager Skandia, 21% of U.K. millionaires made their cash in manufacturing and IT, compared to only 17% in finance. That was a higher proportion making their fortunes from real engineering, as opposed to financial sort, than in France, and higher than in Hong Kong or Singapore, as well.

The U.K.’s manufacturing industry has been picking up speed. Exports of cars have jumped, production in the U.K.’s booming car industry was up 23% in February. Manufacturing now accounts for a larger share of the economy in the U.K. than it does in either France or the U.S. And it has one of the largest Internet economies in the world.

According to a report by the consultants Boston Consulting Group this week, the internet accounts for 8.3% of U.K. GDP — a higher level than any other country in the world (South Korea was in second place, followed by Japan and China). It is a fair bet that some great businesses will emerge from all that activity.

Meanwhile, the number of new company start-ups is rising strongly, they are now at a record level. According to government figures, 435,856 new businesses were registered in 2011, compared to 384,981 in 2010. And in the first two weeks of January, start-ups rose by 12% on the same period last year

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But those entrepreneurs need some help from the government and they aren’t getting any.

The government should be aggressively reducing corporation tax. The Irish slashed company taxes in the 1990s, and were rewarded with a flood of inward investment. It worked for them and it could work for the U.K. as well.

It should be rolling back employment legislation. The bloated public sector is going to be cutting jobs for years to come and the private sector will have to create jobs to replace them. It won’t do that unless regulations are relaxed.

And it should dramatically ease planning restrictions. Right now, it is virtually impossible to get permission to build new houses, or factories, or shops. Even changing the use of existing buildings is very difficult. But, a few internet start-ups aside, businesses need premises. If they can’t get them, they can’t expand.

Cameron and Osborne are now going into the third year of what will probably only be a four-year government. The coalition is unlikely to survive a full-term, and even if it does the last year will be taken up with electioneering.

If they don’t start making big changes now, there won’t be any time left.

For investors, the U.K. could be an attractive market to buy if it had the right policies. But without them? Those sparks of an enterprise-led recovery will quickly splutter out, and its economy is going remain a mixture of money-printing and stagnation.

Lynn is chief executive of Strategy Economics, a London-based consultancy. His latest book ‘The Long Depression: The Slump of 2008 to 2031’ is published by Endeavour Press.

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